Central Clearing Regime and Risk Mitigation Techniques under EMIR: a new era for derivatives

Central Clearing Regime and Risk
Mitigation Techniques under EMIR:
a new era for derivatives
Student ID: 120491430
Supervisor's Name: Leon Vinokur
Institution Name: Queen Mary University of London
Course: MSc in Law & Finance 2013 – 2014
Word Count: 14.452
1

Abstract
The main purpose of this Dissertation is to discuss two fundamental pillars of the
new European Market Infrastructure Regulation: the Central Clearing Regime for
standardised OTC derivatives contracts, and the Risk Mitigation Techniques that
participants must implement when trading non standardised derivatives products.
In Chapter I we briefly illustrate the basic stimulus for the reform, explicitly
referencing to the European Commission statements and proposals.
In Chapter II we firstly analyse the hazardous relation between systemic risk and
derivatives markets, and how it concretely manifests in the real economy.
Secondly, we look at the role of Central Conterparties in this new legal framework,
trying to determine the associated macro-financial implications; in particular, we
focus on the liquidity risk potentially stemming from such infrastructures, which
might cause severe financial downturns especially affecting small market
participants.
In Chapter III, we examine the new Risk Mitigation Techniques for non-clearable
derivatives products; again, critics on how these measures will likely impact market
liquidity and economic prosperity will be provided.
2

Index
Abstract …........2
Introduction …........4
Chapter I - A safer approach towards OTC Derivatives markets: the innovative European
Market Infrastructure Regulation …........7
Section 1
1.1 EMIR rationale and main provisions…........7
1.2 Exemptions for non-financial counterparties…........10
Chapter II - Central Clearing VS Systemic Risk: a Systemically Important Affair…........13
Section 1
1.1 The problem: Systemic Risks in the derivatives markets…........14
Section 2
2.1 The solution: Central Clearing…........17
2.2 Central Counterparties infrastructural functioning…........17
2.3 The risk-management framework…........20
2.4 Risks faced by CCPs…........21
2.5 CCPs Credit Exposures…........24
2.6 The CCPs Waterfall…........26
2.7 Margin Requirements rationale and the RTS on Margin Methodologies…........29
2.8 Portfolio Margining and Cross-Margining…........32
Section 3
3.1 Reducing risks through Risk Concentration in a Liquidity Concentration regime: a beneficial
paradox?…........34
Chapter III - Risk Mitigation Techniques: yearning for liquidity…........38
Section 1
1.1 The Regulatory Technical Standards…........39
Section 2
2.1 Initial Margin…........41
2.2 Variation Margin…........42
2.3 The Concentration limit and the Re-hypothecation prohibition…........43
2.4 The Non-Standard Initial Margin Model…........45
2.5 The Standard Initial Margin Model…........47
2.6 Gross Requirement Calculation…........48
2.7 Net Initial Margin calculation…........49
Section 3
3.1 Risk Mitigation Techniques and Liquidity Risk: possible imbalances among market
participants…........50
Concluding Remarks…........53
Bibliography…........55
3

Introduction
The Financial Crisis of 2007-2009 has shown to the financial and non-financial world
that the significance of OTC Derivatives Markets have been underestimated for
too long. The defaults of Lehman Brothers, Bear Stearns and AIG of 2008 have
highlighted the profound deficiencies in this matter of financial regulation, and
demonstrated how greatly institutions of different sizes are interconnected in
globalised financial markets.
This led to the proposition and adoption of a Regulation specifically addressing the
main problematics related to OTC derivatives: the European Market Infrastructure
Regulation. In the European Commission view, the financial crisis that affected the
system as a whole and the impact of single failures directly and indirectly related
to derivatives transactions shown that the risks of OTC markets were not sufficiently
mitigated and transparent, also because of the increasing complexity of financial
products offered to non-professional investors, causing in turn a complex tangle of
interdependences among market operators; thus, we can summarise that the
leading drivers for an OTC Markets reform are:
- Excessive risk taken by counterparties;
- Poor collateralisation standards;
- High interdependences among market participants.
To address such issues, European Regulators headed towards two main broad
directions: firstly, they have built a legal and financial framework in which Central
Counterparties are empowered to clear the largest share of OTC derivatives
contracts, condition achieved via standardisation processes; secondly, they have
delegated the Joint committee of the European Supervisory Authorities to design
the risk management procedures to implement regarding non-centrally cleared
4

OTC derivatives trading.
For such reasons, in this work we will discuss two fundamental pillars of the
Regulation, as well as their potential negative effect: the Central Clearing Regime
for standardised OTC derivatives contracts, and the Risk Mitigation Techniques that
participants must implement when trading non standardisable derivatives
products.
We conclude that the current framework is capable of reducing effectively
financial inefficiencies in the derivatives context, although some open questions
remain regarding the liquidity risk that may manifest quite soon as an unintended
effect of such structure.
5

Chapter I
A safer approach towards OTC Derivatives markets:
the innovative European Market Infrastructure
Regulation
In this chapter we will try to briefly ascertain the logics that lie under the new
European Market Infrastructure Regulation. This is a prerequisite for properly
introduce the core issues of this work, which will be developed in Chapter II and
Chapter III.
6

Section 1
1.1 EMIR rationale and main provisions
"...I congratulate the European Parliament and the Council on reaching
today an important agreement on a regulation for more stability, transparency
and efficiency in derivatives markets. It is a key step in our effort to establish a
safer and sounder regulatory framework for European financial markets. This
matters because we need to restore trust in the financial sector, and because
we need the financial sector to operate on a sound footing to ensure a return
to sustainable growth of the real economy...”
“…The regulation ensures that information on all European derivative
transactions will be reported to trade repositories and be accessible to
supervisory authorities, including the European Securities and Markets
Authority (ESMA), to give policy makers and supervisors a clear overview of
what is going on in the markets. The era of opacity and shady deals is over…”
Brussels, 9 February 2012
Statement by the Vice-President of the European Commission Michel Barnier, following the agreement in trilogue of new European
rules to regulate financial derivatives1
.
After the Great Recession, economies worldwide required radical changes related
to financial regulation. During the 2009 G-20 Pittsburgh summit, which was one of
the several meetings held in response of the financial crisis of 2007–2008, world
leaders made an agreement on new regulations for Over-the-Counter
derivatives2
.
Derivatives are financial contracts whose value (hence price) is derived from one
or more underlying assets. They can be exchange-traded or Over-The-Counter
(OTC): when a derivative contract is OTC, it means that that contract is negotiated
between two parties and that it is not traded on any regulated market3
,
1
http://ec.europa.eu
2 Article 2 of EMIR: ‘OTC derivative’ or ‘OTC derivative contract’ means a derivative contract the execution of which does
not take place on a regulated market as within the meaning of Article 4(1)(14) of Directive 2004/39/EC or on a third- country
market considered as equivalent to a regulated market in accordance with Article 19(6) of Directive 2004/39/EC
3 Article 2 of EMIR explicitly refers to the place of execution: “...a derivative contract the execution of which does not take
place on a regulated market”. The characteristics that these contracts have in common with exchange traded derivatives
7

consequentially implying that there is not the typical supervision of organised
exchanges regarding the enforceability as well as the marketability of the
contract.
At the time this agreement came into place, no official rules existed for
counterparties involved in OTC derivatives transactions, although there were
diffused private agreements based on prescribed form4
. This meant that
counterparties involved in such contracts were able to customize almost every
aspect of the contract traded, including the determination of collateral
exchanged to cover the financial exposure of counterparties as well as the rules
governing the processes by which that collateral needs to be adjusted over time
due to market conditions; in other words, OTC derivatives trading involved
reciprocal credit risk among counterparties, where the amount and form of risk
assumed was a function of the risk tolerances, objectives, and exposures assessed
and decided by counterparties themselves.
The aim of the European Market Infrastructure Regulation (EMIR) is to regulate
practices of trading, in order to increase the stability of the OTC derivative markets
amid European countries5
. This has to be obtained laying down a common
European framework for the regulation of derivatives traded outside regulated
markets, with the primary aim of reducing the systemic risks connected to them.
In the European Commission view, the financial crisis that affected the system as a
whole and the impact of single failures directly and indirectly related to derivatives
transactions6
shown that the risks of OTC markets were not sufficiently mitigated
and transparent, also because of the increasing complexity of financial products
offered to non-professional investors, causing in turn a complex tangle of
interdependences among market operators; thus, we can summarise that the
(ETD) are thus, as specified by ESMA, not relevant for the purpose of the definition of OTC derivatives.
4 In 2013, ISDA Master Agreements accounted to 87% of non-cleared OTC (bilateral) transactions subject to collateral
agreements – ISDA Margin Survey of 2014
5 European Commission (2010) proposal for a regulation of the European Parliament and of the Council on OTC
Derivatives, Central Counterparties and Trade Repositories
6 See Chapter II
8

leading drivers for an OTC Markets reform are7
:
- Excessive risk taken by counterparties;
- Poor collateralisation standards;
- High interdependences among market participants.
To address such issues, European Regulators headed towards two main broad
directions: firstly, they have built a legal and financial framework in which Central
Counterparties8
are empowered to clear the largest share of OTC derivatives
contracts, condition achieved via standardisation processes9
; secondly, they have
delegated the Joint committee of the European Supervisory Authorities10
to design
the risk management procedures to implement regarding non-centrally cleared
OTC derivatives trading.
The Regulators intention hence is to standardize derivative contracts as much as
possible, consequently bringing their trading and/or clearing onto exchanges. This
idea comes from the recognition of the fact that the practice of frequently settling
the unrealized valuation changes between two parties using variation margin is
beneficial in reducing counterparty risk because it avoids the manifestation of
large, unrealized exposures that could become destabilizing in periods of market
stress11
.
Moreover, Regulators realised that by removing bilateral agreements, the
7 EUROPEAN COMMISSION (2010) PROPOSAL FOR A REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL ON ENERGY MARKETS INTEGRITY AND
TRANSPARENCY
8 See Chapter II
9 ESMA has been empowered to determine which OTC derivative products should be standardised and cleared centrally
accordingly. In determining whether an OTC derivative class is standard or not, ESMA took into account the degree of
standardisation of a product’s contractual terms and operational processes, the volume, the liquidity of the market for
the product in question, and the availability of fair, reliable and generally accepted pricing information of the relevant
class of OTC derivative contract. See European Union (2012) REGULATION (EU) NO 648/2012 OF THE EUROPEAN PARLIAMENT AND OF
THE COUNCIL OF 4 JULY 2012 ON OTC DERIVATIVES, CENTRAL COUNTERPARTIES AND TRADE REPOSITORIES, and ESMA Public Register for the
Clearing Obligation under EMIR of March 2014
10 Composed by the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority
(EIOPA) and the European Securities and Markets Authority (ESMA)
1111 ISDA Non-Cleared OTC Derivatives: Their Importance to the Global Economy – March 2013
9

emerging European Central Counterparties will absorb the risks faced by individual
firms and act as a cushion in the event of market stress.
Finally, by setting robust and standardised practices for the regulation of non-
centrally cleared OTC transactions, Regulators are preventing market participants
to enter into agreements lacking of appropriate risk-reducing measures.
Consequently, the rationale of this regulation comes from the belief that by
bringing OTC derivatives into this framework, markets transparency will increase,
allowing regulators and market participants to understand, monitor, and manage
this activity better, eventually reducing systemic risk. This has to be achieved
through four key provisions:
1 – Reporting obligation for all derivatives contracts;
2 - Clearing obligation for OTC derivatives contracts meeting certain requirements
(eligible derivatives/plain);
3 – The adoption of risk mitigation techniques for non-cleared OTC derivatives;
4 - Legal and technical requirements for trade repositories (TRs) and for clearing
houses/central counterparties (CCPs).
1.2. Exemptions for non-financial counterparties
EMIR provisions are binding in their entirety among all Member States, and must
also be applied to any OTC derivative contracts entered into between third
country entities that would be subject to those obligations if they were established
in the Union, provided that those contracts have a direct, substantial and
foreseeable effect within the Union or where such obligation is necessary or
10

appropriate to prevent the evasion of any provision of this Regulation.
This means that EMIR applies to any party that trades derivatives, thus affecting not
only the banking and financial services sector, but also corporations in the real
economy. Hence, in order to avoid disproportionate burden to small sized
companies, Regulators made a distinction between financial and non-financial
counterparties: financial counterparties comprehend investment firms, credit
institutions, insurance firms, assurance undertakings, credit institutions, UCITS12
,
institutions for occupational retirement provision, and alternative investment
funds13
, whereas counterparties that are not classified as financial are non-
financial.
Non-financial counterparties below an operational threshold14
have the sole
obligation to report all the derivatives contracts entered into OTC and/or
exchange-traded to Trade Repositories15
, whereas financial corporations and non-
financial corporations above the operational threshold, must also adhere to the
clearing obligations16
and the risk management techniques17
.
Finally, until August 2015, there is an exemption in the calculation of thresholds for
OTC derivative contracts entered into by non-financial counterparties in order to
objectively reduce risks; Article 10 of the Commissioned Delegated Regulation (EU)
12 Undertaking for Collective Investment in Transferable Securities
13 EUROPEAN COMMISSION (2010) PROPOSAL FOR A REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL ON OTC DERIVATIVES, CENTRAL
COUNTERPARTIES AND TRADE REPOSITORIES
14 Article 11
(Article 10(4)(b) of Regulation (EU) No 648/2012)
Clearing thresholds
The clearing thresholds values for the purpose of the clearing obligation shall be:
(a) EUR 1 billion in gross notional value for OTC credit derivative contracts;
(b) EUR1 billion in gross notional value for OTC equity derivative contracts;
(c) EUR 3 billion in gross notional value for OTC interest rate derivative contracts;
(d) EUR 3 billion in gross notional value for OTC foreign exchange derivative contracts;
(e) EUR 3 billion in gross notional value for OTC commodity derivative contracts and other OTC derivative contracts not
provided for under points (a) to (d).
15 See note 19
16 See Chapter II
17 See Chapter III
11

No 149/201318
, set the criteria for establishing which OTC derivative contracts are
included19
.
18 Supplementing regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public
register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives
contracts not cleared by a CCP
19An OTC derivative contract shall be objectively measurable as reducing risks directly relating to the commercial activity
or treasury financing activity of the non-financial counterparty or of that group, when, by itself or in combination with other
derivative contracts, directly or through closely correlated instruments, it meets one of the following criteria:
(a) it covers the risks arising from the potential change in the value of assets, services, inputs, products, commodities or
liabilities that the non-financial counterparty or its group owns, produces, manufactures, processes, provides, purchases,
merchandises, leases, sells or incurs or reasonably anticipates owning, producing, manufacturing, processing, providing,
purchasing, merchandising, leasing, selling or incurring in the normal course of its business;
(b) it covers the risks arising from the potential indirect impact on the value of assets, services, inputs, products, commodities
or liabilities referred to in point (a), resulting from fluctuation of interest rates, inflation rates, foreign exchange rates or credit
risk;
(c) it qualifies as a hedging contract pursuant to International Financial Reporting Standards (IFRS) adopted in accordance
with Article 3 of Regulation (EC) No 1606/2002 of the European Parliament and of the Council.
12

Chapter II
Central Clearing VS Systemic Risk: a Systemically
Important Affair
As outlined in Chapter I, with the EMIR regulators are trying to reduce systemic risk
connected to derivatives trading through:
- a central clearing regime for standardised contracts, and through
- the implementation of standard Risk Mitigation Techniques (RMT) for non-cleared
derivatives.
In this chapter we will investigate the relation between systemic risk and the
central clearing regime, drawing benefits and shortcomings that are expected to
realise in these first years of implementation. Risk Mitigation Techniques will be
discussed in Chapter III.
13

Section 1
1.1 The problem: Systemic Risks in the derivatives
markets
Systemic Risk may not be described using a unique definition. Its essence is
inextricably linked to the system or sector to which it relates. For our purposes, we
should concentrate on how derivatives markets are affected by events that can
be associated with systemic risk in one of its facets.
From a broad perspective, systemic risk refers to the risk or probability of
breakdowns in a definite but entire system or sector, caused by a major event
that is capable of igniting a chain reaction responsible for the collapse; more
precisely, we could define it as the risk that the failure of one significant
participant to make payments could result in their counterparty's suspension of
payments, causing a rapid, global transmission of defaults to numerous
participants wedded to the initial failed participant by OTC derivatives
contracts20
.
Interestingly enough, since the 80’s onwards academics, regulators and
business people were definitely aware of the risk stemming from these growing
markets, even due to huge losses already suffered by large institutions by that
time21
. Probably the most emblematic case to mention when talking about OTC
contracts related losses is yet the Metallgesellschaft AG one, dated 1992. In that
year, one division of this company, responsible for the US petroleum marketing,
offered to oil and petrol retailers unusual 5-year and 10-year fixed price contracts.
The Company then aggressively hedged these long-term oil commitments on a
one-to-one basis with short-term futures, i.e. buying one barrel of short-term energy
20
WALDMAN, Adam R. 1994 OTC DERIVATIVES & SYSTEMIC RISK: INNOVATIVE FINANCE OR THE DANCE INTO THE
ABYSS?
21 WALDMAN, Adam R. 1994 OTC DERIVATIVES & SYSTEMIC RISK: INNOVATIVE FINANCE OR THE DANCE INTO THE ABYSS?
14

futures/swaps for each barrel of oil that it was committed to deliver, regardless the
contract maturity (from 0.5 to 10 years). The fundamental mistake in this 1:1
hedging strategy created by MG-AG’s advisers has been to estimate an
unreasonable high-risk premium in oil futures prices, which have instead declined
dramatically erasing any volatility. Finally, at the end of 1993, when the spot price
of oil fell far below the price of the positions in oil future, the company suffered
losses amounting to 1.59 billion, for then being bailed-out for 2.2 billions circa.
A part from more specific observations that lie outside our topic, two focal lessons
can be drawn from this case: the company was over-hedged (i.e. it should have
considered a <1 hedge ratio), and the maturity mismatch (i.e. the hedging
instrument maturity compared to the maturity of the underlying assets) was
excessive; this case clearly illustrates how derivatives can be dangerous when not
properly managed.
Nevertheless, those numbers has been largely exceeded in more recent times:
in 2008 Morgan Stanley lost USD 9 bn22
on Credit Default Swaps, and in Europe
in the same year Société Générale lost EUR 4.9 bn23
(USD 7.22 bn) on European
Index Futures. These examples convey the emergent magnitude of potential
losses affecting Financial Institutions in derivatives trading, though the most
worrying aspect is represented by the latent chain reaction that may very likely
realise as a consequence of such events, leading in turn to a global
transmission of default.
Indeed, when such losses stem from individual incorrect strategies not followed
at all by other market participants, as it has been for Metallgesellschaft in its
downward spiral, the implied risks remain within the company, although
concerns about bail-out appropriateness naturally arise; conversely, when
these phenomena occur in entire market segments, possibly due to regulatory
22 en.wikipedia.org/wiki/List_of_trading_losses
23 en.wikipedia.org/wiki/List_of_trading_losses
15

wrong incentives that foment catastrophic behaviour by financial as well as
non-financial institutions, risks may result of systemic dimension. Not secondly,
the range of such operations is very hard to determine in a market framework
in which data and statistics are not publicly disclosed to whom these info may
concern24
.
Hence, the correct regulatory framework is essential for long-term financial
stability and prosperity, attainable through the implementation of efficient and
reliable systemic risk-reducing measures. The conditio sine qua non to achieve
this result is, however, an efficient, coordinated and reliable data processing-
tracking network, which has become the commitment of Trade Repositories,
which will not be examined in this work25
.
24 The COMMISSION DELEGATED REGULATION (EU) No 153/2013 of 19 December 2012 supplementing Regulation (EU) No
648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on requirements for
central counterparties, in its article 10, minutely describe CCPs' public Disclosure Obligations:
“A CCP shall make the following information available to the public free of charge: (a) information regarding its
governance arrangements, including the following: (i) its organisational structure as well as key objectives and strategies; (ii)
key elements of the remuneration policy; (iii) key financial information including its most recent audited financial
statements; (b) information regarding its rules, including the following: (i) default management procedures, procedures and
supplementary texts; (ii) relevant business continuity information; (iii) information on the CCP's risk management systems,
techniques and performance in accordance with Chapter XII; (iv) all relevant information on its design and operations as
well as on the rights and obligations of clearing members and clients, necessary to enable them to identify clearly and
understand fully the risks and costs associated with using the CCP’s services; (v) the CCP’s current clearing services,
including detailed information on what it provides under each service; (vi) the CCP’s risk management systems, techniques
and performance, including information on financial resources, investment policy, price data sources and models used in
margin calculations; (vii) the law and the rules governing: (1) the access to the CCP; (2) the contracts concluded by the
CCP with clearing members and, where practicable, clients; (3) the contracts that the CCP accepts for clearing; (4) any
interoperability arrangements; (5) the use of collateral and default fund contributions, including the liquidation of positions
and collateral and the extent to which collateral is protected against third party claims; (c) information regarding eligible
collateral and applicable haircuts; (d) a list of all current clearing members, including admission, suspension and exit criteria
for clearing membership. Where the competent authority agrees with the CCP that any of the information under point (b)
or (c) of this paragraph may put at risk business secrets or the safety and soundness of the CCP, the CCP may decide to
disclose that information in a manner that prevents or reduces those risks, or not to disclose such information...A CCP shall
disclose to the public, free of charge, information regarding any material changes in its governance arrangements,
objectives, strategies and key policies as well as in its applicable rules and procedures...Information to be disclosed to the
public by the CCP shall be accessible on its website. Information shall be available in at least a language customary in the
sphere of international finance...”
25 To see how these entities operate and how they are regulated in the EMIR context, make head reference to:
REGULATION (EU) No 648/2012 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 4 July 2012 on OTC derivatives,
central counterparties and trade repositories; COMMISSION DELEGATED REGULATION (EU) No 148/2013 of 19 December
2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives,
central counterparties and trade repositories with regard to regulatory technical standards on the minimum details of the
data to be reported to trade repositories; COMMISSION DELEGATED REGULATION (EU) No 150/2013 of 19 December 2012
supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central
counterparties and trade repositories with regard to regulatory technical standards specifying the details of the application
for registration as a trade repository; COMMISSION DELEGATED REGULATION (EU) No 151/2013 of 19 December 2012
supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central
counterparties and trade repositories, with regard to regulatory technical standards specifying the data to be published
and made available by trade repositories and operational standards for aggregating, comparing and accessing the data.
16

Section 2
2.1 The solution: Central Clearing
As mentioned in Chapter I, the leading drivers for an OTC Markets reform are:
- Excessive risk taken by counterparties
- Poor collateralisation
- High interdependences among market participants
CCPs are expected to combat these market inefficiencies through, respectively:
- Their position as independent risk managers
- The establishment of default dedicated funds and standard margins
- The counterparty substitution
In this Section we will analyse how the infrastructure of central counterparties
address such financial disruptions, posing a particular emphasis on the instruments
and procedures they possess to identify, measure, monitor, and manage the
range of risks that arise in or are borne by them.
2.2 Central Counterparties infrastructural functioning
The defining feature of central counterparty clearing is the counterparty
substitution via novation, the mechanism by which the original contract between
the buyer and the seller is extinguished and replaced by two new contracts: one
between the CCP and the buyer, and the other between the CCP and the seller.
In an open-offer system, the CCP extends an open offer to act as a counterparty
to market participants, consequently interposing itself between participants at the
time a trade is executed. If all pre-agreed conditions are met, there is never a
contractual relationship between the buyer and seller. Where supported by the
legal framework, novation, open offer, and other similar legal devices give market
17

participants legal certainty that a CCP is supporting the transaction26
.
High interdependences among market participants are cradles of Systemic Risk27
,
and counterparty substitution is capable of reducing them. The following
illustration shows how counterparty relationship in a bilateral regime differs from
that in a central clearing regime, thus how counterparty substitution works and
interconnections decrease:
Bilateral Regime
Dealer A --- Dealer B --- Dealer C --- (Dealer A)
Central Clearing Regime
|Dealer A|--- CCP ---|Dealer B|
|Dealer B|--- CCP ---|Dealer C|
|Dealer C|--- CCP ---|(Dealer A)|
As the above picture illustrates, central counterparty clearing simplifies and
reduces interconnections among market participants. CCP becomes in such
manner a principal counterparty to all trades it accepts for clearing, with the
guarantee to perform such trades in its own account in case any member defaults
or is unable to fulfil its obligations, in order to prevent unjustified losses in detriment
of diligent counterparties and the system as a whole.
Indeed, as outlined in Paragraph I, the inability of a bilateral counterparty to fulfil its
obligations, whatever the reason, may disrupt the performance expectations of
the defaulter’s immediate counterparties, as well as others who did not deal
directly with the defaulter. Remote counterparties in the credit chain are thus
26 CPSS-IOSCO – Principles for financial market infrastructures – April 2012
27 European Commission, 2010: Proposal for a Regulation of the European Parliament and of the Council on energy market
integrity and transparency
18

dependent upon the ability and willingness to perform of a party with whom they
did not deal directly and whose creditworthiness they may not be able to
evaluate28
. By its interposition, a CCP eliminate or at least reduce this
interconnection, being the counterparty designed to absorb any member's
default.
Moreover, as a consequence of counterparty substitution, CCPs are capable of
adjusting clearing members’ open positions automatically by offsetting, i.e.
extinguishing a position by entering into an equal and opposite trade with any
other market participant, consequently eliminating the market and counterparty
credit risk of open positions. Here stands one of the great benefit of such market
infrastructures: clearing members have the ability to enter into an opposite trade
with any other clearing member of the CCP without the need for any other
bilateral interaction with the original counterparty.
Furthermore, because the CCP becomes the substituted counterparty to all
transactions submitted for clearing, open positions can be multilaterally net,
consequently reducing margin requirements and associated payment obligations.
Netting offsets obligations between or among participants in the netting
arrangement, thus reducing the number and value of payments or deliveries
needed to settle a set of transactions: undoubtedly, this can effectively reduce
potential losses in the event of a participant default and may reduce the
probability of defaults.
In essence, the CCP is a platform both for the management of counterparty credit
risk and an institution designed to foster market liquidity29
: central counterparty
clearing results in the automatic termination of economically superfluous (i.e.
“offsetting”) positions. This capability of CCPs to terminate open positions by
entering into opposite trades with any other clearing member without the
necessity of any other bilateral interaction with the original counterparty,
28 Robert Steigerwald (2014) Central Counterparty Clearing and Systemic Risk Regulation
29 Robert Steigerwald (2014) Central Counterparty Clearing and Systemic Risk Regulation
19

eventually promotes liquidity, which in turn strengthen financial stability.
Nonetheless, the possibility of counterparty default and the associated credit risk
do not disappear from the aforementioned sequence of transactions simply
because the CCP has been interposed as common counterparty; the
recollocation of the credit risk does not eliminate the systemic risk aspect of
derivatives trading, but rather concentrates it in a small number of CCPs. The
pivotal need hence is to regulate these new storages of liquidity and their risk
management practices meticulously. This aspect will be discussed however in
Paragraph 3.1.
2.3 The risk-management framework
As seen in the previous paragraph, CCPs have the potential to reduce significantly
risks to participants through the multilateral netting of trades and through the
imposition of more effective risk controls on all participants; still, there are several
complications that are intended to magnify as the dimension and the correlated
influences of CCPs increase. CPSS-IOSCO, in their Principles for financial market
infrastructures of April 2012, when defining the principle that such entities must
follow regarding the comprehensive management of risks, state that:
“An FMI should have a sound risk-management framework for comprehensively managing legal,
credit, liquidity, operational, and other risks”
In detail, any CCP must take an integrated and comprehensive view of its risks,
including the risks it bears from and poses to its participants and their customers, as
well as the risks it bears from and poses to other entities, such as other CCPs,
settlement banks, liquidity providers, and service providers; a CCP must consider
how various risks relate to, and interact with, each other. This, through a sound risk-
management framework including policies, procedures, and systems that enable
20

such institutions to identify, measure, monitor, and manage effectively the range
of risks that arise in or are borne by the institution itself30
.
Regulation (EU) No 153/2013 supplementing the RTS on requirements for CCPs, in its
Article 4 (Risk management and internal control mechanisms), establishes that:
“...in establishing risk-management policies, procedures and systems, a CCP shall
structure them in a way as to ensure that clearing members properly manage and
contain the risks they pose to the CCP...A CCP shall take an integrated and
comprehensive view of all relevant risks. These shall include the risks it bears from
and poses to its clearing members and, to the extent practicable, clients as well as
the risks it bears from and poses to other entities such as, but not limited to
interoperable CCPs, securities settlement and payment systems, settlement banks,
liquidity providers, central securities depositories, trading venues served by the
CCP and other critical service providers...”
In sum, the aforementioned Regulation has confirmed and expanded what
designed by CPSS-IOSCO regarding the risk-management policies that CCPs must
adopt and implement. Undoubtedly, this legal framework ensures state-of-the-art
safety standards in the context of Systemic Risk policies, through an array of
instruments depicted in the forthcoming paragraphs; nonetheless, it is worth
stressing, the complexity of financial markets combined with the risks that
revolutionary measures inherently bring to the system, requires regulators as any
other participant the highest prudence and responsiveness to any tiniest risk factor.
21

2.4 Risks faced by CCPs
In order to identify those risks that could materially affect the ability to perform or
to provide services as expected, CCPs must consider a number of potential risk
sources. These are typically categorised as follow:
- Credit risks, which arise when a counterparty becomes unable to meet fully its
financial obligations when due or at any time in the future. In particular, we
distinguish between Principal risk (i.e. the risk that a counterparty lose the full value
involved in a transaction), and the Replacement-cost risk (i.e. the risk of loss of
unrealised gains on unsettled transactions with a counterparty causing an
exposure equal to the cost of replacing the original transaction at current market
prices). Credit risk can also stem from other sources, such as the failure of
settlement banks, custodians, or linked CCPs to meet their financial obligations.
- Liquidity risks, represented by the risk that a counterparty, whether a participant
or other entity, will have insufficient funds to meet its financial obligations as and
when expected, although it may be able to do so in the future. As a
consequence, Liquidity risk includes the risk that a seller of an asset will not receive
payment when due: in this case, the seller may have to borrow or liquidate assets
to fulfil its obligations with other subjects. Liquidity risk may also arise with the buyer
of an asset, when he does not receive delivery when due: similarly, the buyer may
have to borrow the asset in order to complete its own delivery obligations with
others. Hence, both parties to a financial transaction are potentially exposed to
liquidity risk on the settlement date.
Liquidity problems have the potential to create systemic problems, particularly if
they occur when markets are closed or illiquid or there is high volatility for the
underlying asset.
- Legal risks, represented by the risk of an unexpected application of a law or
regulation resulting in a loss. Legal risk can also arise if the application of relevant
22

laws and regulations is uncertain. For example, legal risk comprises the risk that a
counterparty faces from an unexpected application of a rule that renders
contracts illegal or unenforceable. Legal risk also includes the risk of losses resulting
from a delay in the recovery of financial assets or a freezing of positions resulting
from a legal procedure.
- Market risks, which relate to the possibility that a company’s financial instruments
will decline in value. Market risk reflects the day-to-day fluctuations in the price of
a financial instrument, thus its volatility: the greater the volatility, the greater
potential gains/losses.
- Operational risks, arising when deficiencies in information systems or internal
processes, human errors, management failures, or disruptions from external events
result in the reduction, deterioration, or breakdown of services provided by a CCP.
These operational failures may lead to consequent delays, losses, liquidity
problems, and in some cases systemic risks.
- General business risks, referring to the various risks related to the administration
and operation of CCPs as business institutions resulting in a financial condition in
which expenses exceed revenues, so that losses must be charged against capital.
Among these risks, two in particular should greatly concern CCPs: credit and
liquidity risks. Although they are treated as distinct concepts, there is often
significant interaction between these risks: for instance, a large member's default
would likely result in the CCP facing both credit and liquidity risk, potentially
requiring the CCP to draw on its liquidity resources to meet its immediate
obligations. The default of a participant has the potential to cause severe
disruptions to a CCP, its other participants, and the financial markets more broadly.
Therefore, a CCP must establish a robust framework to manage its credit exposures
to its participants and the credit risks arising from its payment, clearing, and
settlement processes31
.
23

2.5 CCPs Credit Exposures
Credit exposure may arise in the form of current exposures, potential future
exposures, or both: current exposure, in this context, is defined as the loss that a
CCP would face immediately if a participant were to default, whereas potential
future exposure is broadly defined as any potential credit exposure that the CCP
could face at a future point in time. In the CCPs framework, credit risk may likely
stem from its members, its payment and settlement processes, or both32
.
A CCP typically faces both current and potential future exposures because it
typically holds open positions with its participants: current exposure arises from
fluctuations in the market value of open positions between the CCP and its
participants, while potential future exposure arises from potential fluctuations in the
market value of a defaulting participant’s open positions until the positions are
closed out, fully hedged, or transferred by the CCP following an event of default.
For instance, during the period in which a CCP neutralises or closes out a position
following the default of a participant, the market value of the position or asset
being cleared may change, which could increase the CCP’s credit exposure,
potentially much. A CCP can also face potential future exposure due to the
possibility for collateral in the form of initial margin to decline significantly in value
over the close-out period.
Current exposures are relatively plain to measure and monitor, provided that
relevant market prices are readily available. On the other hand, potential future
exposures are typically more challenging to measure and monitor, requiring
modelling and estimation of possible future market price developments and other
variables and conditions, as well as specifying an appropriate time horizon for the
close out of defaulted positions. In order to estimate the potential future exposures
that could result from participant defaults, a CCP should identify risk factors and
monitor potential market developments and conditions that could affect the size
24

and likelihood of its losses in the close out of a defaulting participant’s positions. In
sum, CCPs must monitor the existence of large exposures to their direct members
and, where appropriate, their customers. In addition, they should monitor any
changes in the creditworthiness of clearing members.
In order to mitigate its credit risk to the largest possible extent, a CCP must monitor
the evolution of current exposures, by requiring members' open positions to be
marked to market as well as requiring additional funds to be paid in the form of
variation margin, to cover any loss in clearing members positions’ net value on a
daily basis; in this way the accumulation of current exposures are limited and
potential future exposures are mitigated. Therefore, CCPs must have the authority
and operational capacity to make intraday margin calls from clearing members.
Finally, a CCP may choose to place limits on credit exposures, even if
collateralised, and limits on concentrations of positions.
Conclusively, in addition to the identification of the numerous risks that inevitably
lie in their functions, CCPs should employ robust information and risk-control
systems to obtain the accurate and timely measurement and aggregation of risk
exposures across the central counterparty system, the management of members'
individual risk exposures, and the assessment of the impact of unexpected
economic and financial shocks that could affect services performances. Naturally,
CCPs must also monitor its own credit and liquidity exposures, overall credit and
liquidity limits, and the relationship between these exposures and limits.
Regarding clearing members and clearing members' customers data, a CCP
should also provide the relevant information to manage and contain their credit
and liquidity risks through information necessary to monitor their credit and liquidity
exposures, overall credit and liquidity limits, and the relationship between these
exposures and limits. This can also be achieved through the utilisation of incentives
and penalties to clearing members and their customers; for instance, a CCP could
apply financial sanctions to members that fail to settle securities in a timely manner
25

or to repay intraday credit by the end of the operating day. This, along with other
measures, can help reduce the moral hazard that may arise within a sound but
fallible framework.
2.6 The CCPs Waterfall
In the circumstance that clearing members default or do not comply with the
participation requirements, CCPs must follow detailed procedures33
especially
33 Article 48
Default procedures
1. A CCP shall have detailed procedures in place to be followed where a clearing member does not comply with
the participation requirements of the CCP laid down in Article 37 within the time limit and in accordance with the proced-
ures established by the CCP. The CCP shall set out in detail the procedures to be followed in the event the default of a
clearing member is not declared by the CCP. Those procedures shall be reviewed annually.
2. A CCP shall take prompt action to contain losses and liquidity pressures resulting from defaults and shall ensure
that the closing out of any clearing member’s positions does not disrupt its operations or expose the non-defaulting clearing
members to losses that they cannot anticipate or control.
3. Where a CCP considers that the clearing member will not be able to meet its future obligations, it shall promptly
inform the competent authority before the default procedure is declared or triggered. The competent authority shall
promptly communicate that information to ESMA, to the relevant members of the ESCB and to the authority responsible for
the supervision of the defaulting clearing member.
4. A CCP shall verify that its default procedures are enforceable. It shall take all reasonable steps to ensure that it
has the legal powers to liquidate the proprietary positions of the defaulting clearing member and to transfer or liquidate the
clients’ positions of the defaulting clearing member.
. Where assets and positions are recorded in the records and accounts of a CCP as being held for the account of
a defaulting clearing member’s clients in accordance with Article 39(2), the CCP shall, at least, contractually commit itself
to trigger the procedures for the transfer of the assets and positions held by the defaulting clearing member for the account
of its clients to another clearing member designated by all of those clients, on their request and without the consent of the
defaulting clearing member. That other clearing member shall be obliged to accept those assets and positions only where it
has previously entered into a contractual relationship with the clients by which it has committed itself to do so. If the transfer
to that other clearing member has not taken place for any reason within a predefined transfer period specified in its operat-
ing rules, the CCP may take all steps permitted by its rules to actively manage its risks in relation to those positions, including
liquidating the assets and positions held by the defaulting clearing member for the account of its clients.
6. Where assets and positions are recorded in the records and accounts of a CCP as being held for the account of
a defaulting clearing member’s client in accordance with Article 39(3), the CCP shall, at least, contractually commit itself to
trigger the procedures for the transfer of the assets and positions held by the defaulting clearing member for the account of
the client to another clearing member designated by the client, on the client’s request and without the consent of the de-
faulting clearing member. That other clearing member shall be obliged to accept these assets and positions only where it
has previously entered into a contractual relationship with the client by which it has committed itself to do so. If the transfer
to that other clearing member has not taken place for any reason within a predefined transfer period specified in its operat-
ing rules, the CCP may take all steps permitted by its rules to actively manage its risks in relation to those positions, including
liquidating the assets and positions held by the defaulting clearing member for the account of the client.
7. Clients’ collateral distinguished in accordance with Article 39(2) and (3) shall be used exclusively to cover the
positions process by the CCP shall be readily returned to those clients when they are known to the CCP or, if they are not, to
the clearing member for the account of its clients.
26

designed to avoid disruptions to non-defaulting clearing members; Central
Counterparties Default Procedures are nevertheless outside our field of research,
while pertinently to the purposes of this paper we will focus on the scheme used by
CCPs to manage losses caused by participants defaults.
In such events, CCPs typically use a sequence of prefunded financial resources
often known as the “waterfall”: it represents the array of financial safeguards
available to a CCP and the order in which they would be depleted in the event of
a clearing member's default. The waterfall normally include:
- a defaulter’s initial margin,
- the defaulter’s contribution to a prefunded default arrangement,
- a specified portion of the CCP’s own funds, and
- other participants’ contributions to a prefunded default arrangement.
In August 2013, ISDA has published a paper entitled “CCP Loss Allocation at the
End of the Waterfall”, in which the association among other issues suggest a
“Desirable CCP Default Waterfall” structure, including:
- an Initial Margin (IM) composed of securities or cash. It represents the first and
principal “insurance” against default;
- a Defaulting Member’s default fund contribution, to be used before those of non-
defaulting Clearing Members;
- the Tranche of CCP’s capital, part of CCP’s own capital;
Article 37
General requirements
A CCP shall establish and implement transparent and predictable policies and procedures to assess and
continuously monitor the liquidity of assets accepted as collateral and take remedial action where appropriate.
A CCP shall review its eligible asset policies and procedures at least annually. Such a review shall also be carried
out whenever a material change occurs that affects the CCP’s risk exposure held for their account. Any balance owed
by the CCP after the completion of the clearing member’s default management
27

- default fund contributions of surviving (non-defaulting) Clearing Members
- an additional unfunded default fund contributions, which may be defined as
multiples of the funded Default Fund contribution;
- an Additional CCP capital tranche;
- a Variation Margin Gains Haircutting (VMGH), i.e. the haircutting of unpaid
Variation Margins, a mechanism designed to allocate additional losses using
cumulative clearing members' variation margin gains that have accumulated
since the day of the default in question.
Initial margin is used to cover a CCP’s potential future exposures, as well as current
exposures not covered by variation margin, to each participant with a confidence
level of at least 99 per cent of the estimated distribution of future exposure.
Notwithstanding, CCP remain exposed to residual risk (or tail risk) if a participant
defaults and market conditions concurrently change more drastically than is
anticipated in the margin calculations: risks can be reduced, not avoided. The
only feasible solution to avoid losses for CCPs is to maintain additional financial
resources, such as additional collateral or a prefunded default arrangement, to
cover a portion of this residual risk.
In addition to fully covering its current and potential future exposures, CCPs should
maintain additional financial resources sufficient to cover a wide range of
potential stress scenarios involving extreme but plausible market conditions34
.
Specifically, a CCP that is involved in activities with a more-complex risk profile or
that is systemically important in multiple jurisdictions 35
, should maintain additional
35 CPSS-IOSCO – Principles for financial market infrastructures – April 2012 Determinations of whether a CCP is systemically
important in multiple jurisdictions should include consideration of, among other factors, (a) the location of the CCP’s
participants, (b) the aggregate volume and value of transactions that originate in each jurisdiction in which it operates, (c)
the proportion of its total volume and value of transactions that originate in each jurisdiction in which it operates, (d) the
range of currencies in which the instruments it clears are cleared or settled, (e) any links it has with FMIs located in other
jurisdictions, and (f) the extent to which it clears instruments that are subject to mandatory clearing obligations in multiple
jurisdictions.
28

financial resources sufficient to cover a wide range of potential stress scenarios
that should include, but not be limited to, the default of the two participants and
their affiliates that would potentially cause the largest aggregate credit exposure
for the CCP in extreme but plausible market conditions.
Finally, CCPs should expressly set out the waterfall procedures, explicitly indicating
the circumstances in which specific resources are to be used in a clearing
member's default case.
Article 35 of the Regulation (EU) No 153/2013 supplementing regulatory technical
standards on requirements for central counterparties, set out the rules concerning
the Default Waterfall standards, establishing that CCPs must keep dedicated funds
amounting to the 25% of the legal minimum capital of EUR 7.5 million36
, including
retained earnings and reserves. In presence of more than one fund for different
classes of cleared instruments, the total dedicated resources must be proportion-
ally allotted across the different class-related funds.
2.7 Margin Requirements rationale and the RTS on
Margin Methodologies
An effective margining system is a key risk-management tool for a CCP to manage
the credit exposures posed by its participants’ open positions37
. By collecting
margins, which are deposits of collateral in the form of money, securities, or other
financial instruments, CCPs assure performance and mitigate their credit exposures
for all the products cleared if a participant defaults.
Margin levels should be commensurate with the risks and particular attributes of
36 See Article 16 of the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories.
29

each product, portfolio, and market it serves38
, accounting for the complexity of
the underlying instruments and the availability of timely, high-quality pricing data;
this is particularly true regarding OTC derivatives contracts, because of their
complexity and the greater uncertainty of the reliability of price quotes39
.
Furthermore, the appropriate close-out period may vary among products and
markets depending upon the product’s liquidity, price, and other characteristics,
thus complicating even more the modelling of proper margin estimations. Aware
of such risks, CPSS-IOSCO in their paper40
specify that CCPs should select the
appropriate close-out period for each product cleared, and document the close-
out periods and related analysis for each product type. In the determination of the
close-out periods for the purposes of initial margin modelling, CCPs should consider
historical price and liquidity data, including in the assessment the occurrence of
reasonably foreseeable events in a default scenario41
. Close-out periods should be
set aware that less liquid products normally require appreciably longer close-out
periods.
The close-out period should account for the impact of a participant’s default on
prevalent market conditions, and the related implications should be derived
expecting historical adverse events in the product cleared, such as significant
reductions in trading or other market disruptions; however, the close-out period
can be determined additionally taking into account the CCP’s ability to hedge
effectively the defaulter’s portfolio42
.
Finally, physically deliverable derivatives products bear the additional risk of failed
deliveries of both securities and other relevant instruments, however CCPs should
continue to margin positions for which a participant fails to deliver the required
security or relevant instrument on the settlement date43
.
30

Regulation (EU) No 153/2013 supplementing regulatory technical standards on
requirements for central counterparties, in Article 41 establishes that CCPs shall
impose, call and collect margins to limit its credit exposures from its clearing
members and, where relevant, from CCPs with which it has interoperability
arrangements. Such margins shall be sufficient to cover potential exposures that
the CCP estimates will occur until the liquidation of the relevant positions.
CCPs must calculate the initial margins to cover the exposures arising from market
movements for each financial instrument that is collateralised on a product basis
with a minimum confidence interval of 99.5% for OTC derivatives, and 99% for
financial instruments other than OTC derivatives.
Accommodating CPSS-IOSCO guidelines, for the determination of the adequate
confidence interval for each class of financial instruments to clear, CCP must
consider: the complexities and level of pricing uncertainties of the class of financial
instruments which may limit the validation of the calculation of initial and variation
margin, the risk characteristics of the class of financial instruments (e.g. volatility,
duration, liquidity, non-linear price characteristics, jump to default risk and wrong
way risk), the degree to which other risk controls do not adequately limit credit
exposures, and finally the average volatility of the class of financial instruments as
well as its concentration level in the market and the potential efforts needed to
close out the position44
.
In its margin arrangements, a CCP should appropriately address those procyclical
(i.e. positively correlated) changes in risk management practices that are positively
correlated with market, business, or credit cycle fluctuations, which may cause or
exacerbate financial instability. Such fluctuations indeed, may result in higher
margin requirements for clearing members, intensifying market stress and volatility
further, which in turn leads to supplementary margin requirements.
31

In order to address such margins inefficiencies, to the extent practicable and
prudent, a CCP should adopt forward-looking and relatively stable and
conservative margin requirements that are specifically designed to limit the need
for destabilising, procyclical measures, such as significant unanticipated margin
calls in times of market stress45
. In CPSS-IOSCO view, although these procedures
may create additional costs for CCPs and their participants in periods of low
market volatility, they would be helpful by protecting clearing members in periods
of high market volatility.
2.8 Portfolio Margining and Cross-Margining
Portfolio Margining is one of the “economy-of-scale mechanisms” owned by
central counterparties. With such method, CCPs are able to offset or reduce the
required margin of distinct financial instruments or a set of them, provided that the
associated price risk are significantly and reliably correlated, or based on
equivalent statistical parameter of dependence. Offsets must respect the
aforementioned (see paragraph X) single-tailed confidence level of at least 99 per
cent regarding the estimated distribution of the future exposure of the portfolio.
CCPs must apply such offsets over an economically meaningful methodology that
reflects the degree of price dependence between given products, taking into
account in what way price dependence could vary with overall market conditions
incorporating periods of stress46
. When using portfolio margining, CCPs must
constantly review and test the robustness of its portfolio method on both actual
and appropriate hypothetical portfolios, to assess how correlations behave.
All financial instruments to which portfolio margining is applied must be covered by
32

the same default fund, unless CCPs can demonstrate in advance to the
competent authority and to clearing members how potential losses would be
allocated among different default funds and have set out the necessary provisions
in this sense.
Lastly, Article 27 of Regulation (EU) No 153/2013 dispose that when portfolio
margining covers multiple instruments, the amount of margin reductions shall be no
greater than 80% of the difference between the sum of the margins for each
product calculated on an individual basis and the margin calculated based on a
combined estimation of the exposure for the combined portfolio. Where the CCP
is not exposed to any potential risk from the margin reduction, it may apply a
reduction of up to 100 % of that difference.
All the precautionary procedures described for Portfolio Margining must be
applied to another cost-reducing instrument: the cross-margining. It is an
arrangement under which two or more CCPs agree to consider their respective
positions and supporting collateral as a common portfolio for the CCPs’ clearing
members; when CCPs positions’ value separately considered move in opposite but
symmetric directions, the aggregate collateral requirements for those positions
may be reduced accordingly. For the purpose of cross-margining, CCPs must
share information frequently and jointly monitor positions, margin collections, and
price information. Finally, CCPs involved in such practice should also have
harmonised overall risk management systems and should regularly monitor possible
discrepancies in the calculation of their exposures, especially with regard to
monitoring how price correlations perform over time47
.
Conclusively, portfolio margining allows firms with offsetting risks to offset their
margin accordingly. Despite its evident utility, it remains to assess whether this
practice will translate in excessive discounts for largest players only, due to their
largest offsetting risk, in exchange for an increased credit risk for all or, hopefully, it
33

will reduce costs effectively still providing adequate standards of protection to the
entire market segment.
Section 3
3.1 Reducing risks through Risk Concentration in a
Liquidity Concentration regime: a beneficial paradox?
Once that Central Clearing Counterparties’ functioning and their principal key
issues have been discussed, it is right and proper to examine some last
contradictory aspects of their promotion.
Albeit the consistent benefits that CCPs are expected to bring to financial markets
in terms of trading transparency and multilateral netting efficiencies, there is un
avoidable drawback regulators must now deal with: the concentration risks they
inevitably pose to derivatives market and to the whole financial system. Indeed,
the decision to make mandatory the central clearing of all standardised OTC
derivatives implies the constitution of new systematically important entities within
financial markets. Additionally, the higher costs correlated to non-centrally cleared
OTC derivatives, will plausibly cause market participants to rely increasingly on
standardised instruments48
. Once that trading will progressively migrate towards
central clearing however49
, credit, liquidity and operational risk will be
concentrated in these institutions. Consequentially, CCP could become new
potential sources of systemic risk under a new vest, eventually triggering the same
kind of problems they were trying to address.
Banks for their part, will become clearing members, therefore in the case a CCP
48 BIS (2013) Macroeconomic impact assessment of OTC derivatives regulatory reforms
49 ISDA (2013) expect that the share of cleared OTC will settle steadily at 70%. See Non-Cleared OTC Derivatives: Their
Importance to the Global Economy
34

defaults these Institutions will be in the first line of defence due to their expectable
largest share in the default pool; big reductions of big banks liquidity as a
consequence of big CCPs default, will very likely cause disruption to the
Commercial as well as to the Interbank lending system, creating even more
market uncertainty in an already overburdened system in regards of
collateralization and regulatory obligations.
In sum, CCPs’ unavoidable drawbacks are represented by the concentration risk
they pose to the financial system, and by the increased amount of liquidity they
demand for their service.
To deal with the concentration risk, it is essential to assess the fulcrum of the
problem. Since CCPs in this new legal framework are the first responsible and
accountable entities for both the management of stored-in liquidity and the
execution, organization and supervision of standardised derivatives trading, it
appears consequential that the financial healthiness and efficiency of CCPs are
the pivotal targets to pursue, achieve and protect.
Concentration schemes are double-edged swords, hence in the CCPs context as
long as the smoothest functioning and the highest safety standards are granted,
the EMIR framework and the central clearing regime will very likely produce the
benefits they are deemed to: reduce counterparties’ risk, optimize collateralisation
procedures, and improve the configuration of market participants relationships.
Regarding the second disadvantage, it has been estimated that the annual
increased cost deriving from collateral needed to back trades oscillates between
EUR 1.1 trillion and EUR 1.8 trillion, with a central estimate of EUR 1.3 trillion50
.
Notwithstanding the appropriateness of such added costs, it appears crucial to
guarantee that smaller participants will bear proportionally the consequences of
that; the exemptions granted to NFC- alone cannot prevent lending shortages, as
50 BIS (2013) Macroeconomic impact assessment of OTC derivatives regulatory reforms
35

well as other indirect unintended effect stemming from the complexities of
financial intermediation. More liquidity is needed, and this can produce disruptions
or not, depending from the source of the necessary funds: more low-interests rate
loans not affecting investment opportunities, more high-interests rate loans
affecting investment opportunities. These are problems however, that require
further dedicated research. From our point of view, we can remark the conclusion
that the current legal framework is rationally expected to achieve risk
management efficiencies in the derivatives context, though liquidity demand is
deemed to rise and CCPs are destined to become soon Systemically Important risk
containers in a financial system still recovering from the repercussions of derivatives
crashes51
.
51 See Chapter I
36

Chapter III
Risk Mitigation Techniques: yearning for liquidity
As established in ARTICLE 11 of the REGULATION (EU) NO 648/2012 ON OTC DERIVATIVES,
CENTRAL COUNTERPARTIES AND TRADE REPOSITORIES, financial counterparties and non-financial
counterparties that enter into an OTC derivative contract not cleared by a CCP,
shall ensure, exercising due diligence, that appropriate procedures and
arrangements are in place to measure, monitor and mitigate operational risk and
counterparty credit risk, including at least:
- The timely confirmation, where available, by electronic means, of the terms of
the relevant OTC derivative contract;
- Formalised processes that are robust, resilient and auditable in order to reconcile
portfolios, to manage the associated risk and to identify disputes between parties
early and resolve them, and to monitor the value of outstanding contracts.
In this chapter we will discuss the Regulatory Technical Standards regarding the
new margining framework, as well as one problematic connected to it: the
liquidity risk they pose to the system.
38

Section 1
1.1 The Regulatory Technical Standards
The CONSULTATION PAPER ON RISK-MITIGATION TECHNIQUES FOR OTC-DERIVATIVE CONTRACTS NOT
CLEARED BY A CCP of April 2014 has finally drawn the Regulatory Technical Standards
(RTS) to which counterparties above the threshholds52
involved in non-cleared
transactions must adhere from 1 January 2015 onwards53
, although ESA's intention
is to submit the very final draft RTS before the end of 2014. These procedures are
binding in their entirety among all Member States54
, and must also be applied to
any OTC derivative contracts entered into between third country entities that
would be subject to those obligations if they were established in the Union,
provided that those contracts have a direct, substantial and foreseeable effect
within the Union or where such obligation is necessary or appropriate to prevent
the evasion of any provision of this Regulation55
.
The RTS set detailed rules regarding risk management procedures between
counterparties, the margining methods and procedures, the valuation and the
management of collateral, and the operational trading procedures. In this work,
we will focus on the risk management obligations and on the margining
framework.
To begin with, the RTS prescribe the minimum amount of Initial and Variation
Margin to be posted and collected by counterparties to cover the mark-to-market
exposure of non-cleared OTC derivative contracts. Initial and variation margins
must now be collected at least on a daily basis starting from the business day
following the execution of the contract56
. Regarding the Initial Margin,
counterparties may opt for two different methodologies to calculate it:
52
See Chapter I
53 It shall apply from 1 December 2015, see Article 1 FP - RTS
54 Article 1 FP RTS
55 As established by the Article 11 of the REGULATION (EU) NO 648/2012 OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL OF 4 JULY 2012 ON OTC DERIVATIVES, CENTRAL COUNTERPARTIES AND TRADE REPOSITORIES
56 REGULATORY TECHNICAL STANDARDS ON RISK-MITIGATION TECHNIQUES FOR OTC-DERIVATIVE CONTRACTS NOT CLEARED BY A CCP – APRIL 2014
39

- The standard one, eventually developed by ISDA in September 2013 based on
the notional value of the contracts, as well as
- A model developed by the counterparty itself, by the counterparty in
conjunction with another counterparty, or by a third party, where the initial margin
is determined based on the modelling of the exposures.
However, the choice between the two models should be made consistently over
time57
, in order to avoid expense-exploiting strategies.
57 MARGIN REQUIREMENTS FOR NON-CENTRALLY CLEARED DERIVATIVES - SEPTEMBER 2013
40

Section 2
2.1 Initial Margin
Initial margin is the quantification of the risk that a counterparty suffer due to
potential future exposure resulting from upcoming changes in the mark-to-market
value of a contract, during the period the counterparty need to close out and
replace its position in the event that one or more counterparties default58
.
The amount of initial margin hence reflects the size of the potential future exposure
in a transaction, and it depends on a number of factors, such as the contract re-
valuation frequency, the volatility of the underlying instrument, and the expected
duration of the contract closeout and replacement period59
.
Interestingly, the RTS proposed two restrictions to the application of Initial Margin
requirements60
:
- a threshold of up to EUR 50 million of exposures in respect to single counterparties,
under which counterparties would not exchange any Initial Margin;
- a threshold of EUR 500.000 regarding market valuation changes, under which
counterparties would not exchange additional collateral and/or change
contractual conditions.
In the Committee’s stance, these provisions would limit operational burden to
counterparties having no significant exposure (i.e. up to EUR 50 million) to other
counterparties singularly considered, as well as avoid liquidity dry-up risks stemming
from market value fluctuations (i.e. up to EUR 500.000).
The computation models for Initial Margins will be discussed in paragraphs 2.6 and
41

2.7.
2.2 Variation Margin
Variation margin’s amount reflects the current exposures that result from the
actual changes in market prices. In order to quantify the Variation Margin in a
derivatives transaction, counterparties’ open positions need to be marked to
current market prices on a defined frequency61
; committed funds are
consequently collected from (paid to) a counterparty to settle any losses (gains)
on those positions. Alternatively said, Variation Margin protects the transacting
parties from the current exposure that has already been incurred by one of the
parties from changes in the mark-to-market value of the contract after the
transaction has been executed62
.
Due to the potentially significant lack of liquidity for non-centrally cleared
derivatives markets, BCBS-IOSCO in their paper remark the importance of the
adoption of rigorous and robust dispute resolution procedures between
counterparties before the onset of a transaction. In relation with the Variation
Margin, the paper expressly require counterparties to “make all necessary and
appropriate efforts, including timely initiation of dispute resolution protocols, to
resolve the dispute and exchange the required amount of variation margin in a
timely fashion” in the event that a margin dispute arises.
2.3 The Concentration limit and the Re-hypothecation
prohibition
Before discussing closely the margining procedures in the next paragraphs, two
61 MARGIN REQUIREMENTS FOR NON-CENTRALLY CLEARED DERIVATIVES - SEPTEMBER 2013, 3.14: “To reduce adverse liquidity shocks and in
order to effectively mitigate counterparty credit risk, variation margin should be calculated and exchanged for non-
centrally cleared derivatives subject to a single, legally enforceable netting agreement with sufficient frequency (e.g.
daily)”
42

innovative and expectantly fruitful provisions of these RTS deserve to be
mentioned: the Concentration limits and the Re-hypothecation prohibition.
Concentration limits refers to the amount of any kind of allowed collateral, not in
the form of cash, that can be collected for margining purposes from an individual
counterparty, either a single issuer or an entity as defined in Article 2 (16) as well as
2 (24) of Regulation (EU) No 648/2012. In particular, Article 7 LEC establishes
different thresholds for different types of security that counterparties must not
exceed when collecting collateral from a given counterparty; these thresholds
range from 10% (e.g. for gold) to 50% (e.g. for Sovereign)63
.
This provision find its rationale in the consideration that, given the substantial
amounts of collateral that will be required to be posted and collected on initial
and variation margins as a consequence of EMIR, counterparties may risk
becoming overly exposed to specific assets or issuers64
. Indeed, by introducing
diversification requirements on the assets used as collateral, single securities will
face less market risk and single issuers will less likely suffer exposures close-out issues
as a consequence of potential massive liquidation events.
Undoubtedly, the introduction of concentration limits will be burdensome for
counterparties, probably to different extent depending on counterparty’s volume
of trades in the derivatives markets. Nevertheless, time will tell whether market
participants will effortlessly implement these operational innovations or not.
Regarding the re-hypothecation prohibition, let’s outline what the term stands for:
Rehypothecation is “the practice by banks and brokers of using, for their own
purposes, assets that have been posted as collateral by their clients”65
, or
alternatively said, “is the practice of using the assets held as collateral for one
client in transactions for another.”66
65 Investopedia
66 FT Lexicon
43

In our context, counterparties allowing such practice would be certainly
compensated with some benefits from the counterparty allowing it, such as
reductions on borrowing costs, fees etc., thus financial intermediation would be
likely fostered; however, this potential benefit could be seriously outweighed by an
increased risk in cross-default events, due to the potential lack of valuable
collateral as a result of the re-hypothecation.
Aware of such risk, well traceable in real life looking back at the most recent
financial crisis67
, the BCBS-IOSCO in their Margin requirements for non-centrally
cleared derivatives of September 2013, state that: “Initial margin collected should
be held in such a way as to ensure that…the margin collected is immediately
available to the collecting party in the event of the counterparty’s default”, and
that “the collected margin must be subject to arrangements that protect the
posting party to the extent possible under applicable law in the event that the
collecting party enters bankruptcy.”
The rationale of such words probably lie in the consciousness that despite the mar-
gins exchanged between counterparties, the risk of default is not automatically
defeated; moreover, in their view “the risk would be exacerbated if the counter-
party re-hypothecates, re-pledges or re-uses the provided margin”. This con-
sidered, the Committee decided to let each Jurisdiction decide whether prohibit
such practices for initial margins totally or permit them under stringent conditions68
.
Regarding variation margins, in the committee’s stance rehypothecation were to
be allowed69
.
Eventually, RTS fully prohibit rehypothecation on Initial Margins, as decided during
the ESA Roundtable of December 2, 2013.
67 See Lehman Brothers and AIG cases
44

2.4 The Non-Standard Initial Margin Model
The Article 5 MRM of the RTS set the main risk factors that any initial margin model
must incorporate, and impose a back testing programme (and its main
requirements) in order to compare the risk measures generated by the model with
the realized risk measures at least every three months.
When using Non-Standard Model, for the purpose of the initial margins
calculations, the assumed variations in the value of the contracts in the netting set
must be consistent with a one-tailed 99 per-cent confidence interval over a
margin period of risk of at least 10 days70
, taking into account the period that may
elapse from the last collection of the margins up to the declaration of the default
of the counterparty, and the estimated period needed to replace the contracts in
the netting set, considering the level of liquidity, size and concentration of the
positions in relation to the markets where such positions are traded71
.
Internal models must be calibrated based on historical data from a period of at
least three years, covering the most recent continuous period from the calibration
date and containing at least 25% of data deemed representative of a period of
significant financial stress72
; each set of data for each period must be
proportionally weighted in the calculation73
.
The model shall be recalibrated at least every 6 months, and must utilise accurate,
appropriate and complete data74
.
In response to changing market conditions, the model need to provide
procedures for adjusting margin requirements, allowing each counterparty to post
the initial margin resulting from the recalibration of the model over a period longer
70 Article 2 MRM - RTS
72 When this is not the case, the least recent data in the time series must be replaced by data from a period of significant
financial stress, until the overall proportion of stressed data is at least 25% of the overall data set.
73 Article 3 MRM – RTS
45

than one day. These procedures must be transparent and predictable75
.
Initial margin calculations for derivatives in distinct asset classes must be performed
without regard to derivatives in other asset classes; this means that in a derivatives
portfolio consisting of two derivatives of two different category, for instance, the
total initial margin requirement for that portfolio would be the sum of the two
individual initial margin amounts separately calculate, being of two different asset
classes. Finally, derivatives for which a firm faces zero counterparty risk require no
initial margin to be collected and may be excluded from the initial margin
calculation76
.
Finally, in order to adopt the non-standard approach, counterparties shall notify
the relevant competent authorities their intention, supplying the relevant
documentation referred to in Article 6 MRM if required77
; furthermore, in the case
that a non-standard model ceases to comply with the requirements established in
the RTS, counterparties have the duty to notify the relevant competent authorities
and shall compute the required initial margins using the Standardised Method78
.
76 Article 4 MRM - RTS: The total initial margin requirements for a netting set shall be the sum of initial margin requirements
calculated for each underlying class within the netting set.
77 Article 6 MRM - Qualitative requirements, establishes that:
1. Any initial margin model shall be subject to an internal governance process that continuously assesses the validity
of the model’s risk assessments and tests such assessments against realized data. In particular, all of the following qualitative
requirements shall be met:
(a) an initial validation shall be carried out by suitably qualified and independent parties; the validation shall be also
conducted whenever a significant change is made to the initial margin model and at least once a year;
(b) an audit process shall be regularly conducted to assess the integrity and reliability of the data sources and the
management information system used to run the model, the accuracy and completeness of data used, the accuracy and
appropriateness of volatility and correlation assumptions.
2. Counterparties shall have a process for verifying at least annually that the netting agreements considered for the
initial margin calculation are legally enforceable.
3. The documentation shall be sufficient to ensure that any knowledgeable third-party would be able to understand
the design and operational detail of the initial margin model.
4. The documentation shall contain the key assumptions and the limitations of the initial margin model. It shall also
define the circumstances under which the assumptions of the initial margin model should no longer be considered valid.
5. The counterparties shall maintain clear documentation showing all changes to the initial margin model and the
tests performed.
If initial margin models cease to comply with the requirements laid down in this chapter, counterparties shall notify the
relevant competent authorities and shall compute the required initial margins using the Standardised Method.
46

2.5 The Standard Initial Margin Model
Regarding the Standardised Method, on December 2013 ISDA published a paper79
in which they primarily outlined the nine “criteria” that a standard initial margin
model should respect. They relate to the non-procyclicality, the easiness of
replication, the transparency, the simplicity of calculation, the predictability, the
costs, the governance, the margin appropriateness, and finally to the need for this
method to be extensible.
Respectively, the first standard stems from the urge for such models to be inde-
pendent from market levels or volatility, as in ISDA’s stance linking initial margin to
market volatility could violently exacerbate contractual defaults in a time of stress;
the second, third and fourth standards are set as prerequisites to effectively man-
age dispute resolution procedures; the fifth principle expresses the importance to
easily include new risk factors, as well as additional offset recognition, in the model
whenever is appropriate; the sixth standard is fundamental to preserve consistency
in pricing and to allow participants to allocate capital against trades; the seventh
standards refers to the contribution of the regulators about the determination of
the risk factors and the calibration of the model, which should includes data com-
ing from a period of stress; finally, the eight principle comes from the basic need to
ensure all market participants reasonable operational costs and burden regarding
the model eventually fostering access to the non cleared markets, while the last
standard reflects the cognizance of the Board that many types of margin calcula-
tion perform poorly with portfolios that reflect a large number of risk factor, espe-
cially when including different asset classes.
Eventually, after taking carefully under advisement ISDA comments on the Margin-
ing Model design, on April 2014 EBA has finally published the Regulatory Technical
Standards (RTS) to which counterparties involved in non-cleared transactions must
adhere from 1 January 2015, accurately defining the computational procedures
counterparties must follow when electing the Standardised Method. The model re-
79 STANDARD INITIAL MARGIN MODEL FOR NON-CLEARED DERIVATIVES – DECEMBER 2013
47

quires two stages: firstly, it is determined the Gross Requirement, and subsequently
the Net Initial Margin.
2.6 Gross Requirement Calculation
In order to compute the Gross Requirement, the notional amounts or underlying
values, as applicable, of the derivative contracts in a netting set are multiplied by
add-on factors; the netted notional amount is obtained crossing contracts that are
of opposite direction but are identical for all the others contractual features with
the only possible exemption of notional. The aforementioned add-on factors
change in respect of the asset class and the maturity of the contract, and their
computation results in a gross requirement that need further calculations:
Asset class: maturity - Add-on factor80
Credit: 0–2 year residual maturity - 2%
Credit: 2–5 year residual maturity - 5%
Credit: 5+ year residual maturity - 10%
Commodity - 15%
Equity - 15%
Foreign exchange - 6%
Interest rate: 0-2 year residual maturity - 1%
Interest rate: 2-5 year residual maturity - 2%
Interest rate: 5+ year residual maturity - 4%
Other - 15%
Secondly, the gross requirement is reduced to take into account potential
offsetting benefits in the netting set.
80 Table 1 SMI - RTS
48

2.7 Net Initial Margin calculation
The Gross initial margin of a netting set is calculated as the sum of all OTC
derivative contracts not cleared by a CCP81
in the netting set, considered that:
- if a primary risk factor can be clearly identified, contracts shall be assigned to the
category corresponding to that risk factor;
- if this condition is not met, contracts shall be assigned to the category with the
highest add-on factor among the relevant categories.
The following equation shows the initial margin requirements for netting sets:
Net initial margin = 0.4 * Gross initial margin + 0.6 * NGR * Gross initial margin
Where:
Net initial margin = the reduced figure for initial margin requirements for all
derivative contracts with a given counterparty included in a netting set;
and
NGR = the net-to-gross ratio calculated as the quotient of the net replacement
cost of a netting set with a given counterparty (numerator) and the gross
replacement cost of that netting set (denominator); the net replacement cost of a
netting set is defined as the bigger of zero and the sum of current market values of
all derivative contracts in the netting set, whereas the gross replacement cost of a
netting set is defined as the sum of the current market values of all derivative
contracts calculated in accordance with Article 11(2) of Regulation (EU) No
81 As defined in Article 11 of the Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012
on OTC derivatives, central counterparties and trade repositories
49

648/2012 and Articles 16 and 17 of the Commission Delegated Regulation No
149/2013 with positive values in the netting set82
.
Section 3
3.1 Risk Mitigation Techniques and Liquidity Risk:
possible imbalances among market participants
As we have seen in the previous section, the margin framework for OTC non-
cleared derivatives is now composed of two elements: variation margin and initial
margin. Many OTC derivatives transactions currently encompass the practice of
variation margins exchanges83
: an ISDA Margin Survey84
reveals that in 2012 more
than 70% of all OTC derivatives transactions were subject to variation margin
arrangements85
. Variation Margins are thus expected not to cause OTC traders
particular concerns.
On the other hand, Initial Margin is an innovation, therefore its impact on the
market is more challenging to assess; unquestionably, additional costs mean fewer
investments opportunities. Although Initial margins will presumably and effectively
reduce the risk of default contagion across the system protecting non-defaulting
counterparties, they entail two main important drawbacks: one more
straightforward, suffered by counterparties as a direct consequence of the higher
costs connected to trading OTC non-cleared instruments86
, potentially leading to
the risk that participants will not be able to meet these expenditures due to
82 Annex IV of REGULATORY TECHNICAL STANDARDS ON RISK-MITIGATION TECHNIQUES FOR OTC-DERIVATIVE CONTRACTS NOT CLEARED BY A CCP – APRIL
2014
83 See ISDA Master Agreements
84 ISDA Margin Survey - 2012
85 The major exceptions to the practice of posting collateral are sovereigns
86 Estimated EUR 0.7 trillion of collateral on a global basis. See ISDA NON-CLEARED OTC DERIVATIVES: THEIR IMPORTANCE TO THE GLOBAL
ECONOMY- MARCH 2013
50

unchanged funding cost; one broader and rather indirect, represented by the
threat of Market liquidity risk, which is the risk to suffer net losses due to the lack of
marketability of an instrument that cannot be bought or sold fast enough87
. In both
cases, smaller participants are more exposed to these risks than others: they have
less borrowing capacity, and their typical single oriented exposure is highly
detrimental during liquidity stress periods.
Quoting the International Swaps and Derivatives Association: “The importance to
the global economy of the non-cleared OTC derivatives market implies that any
impairment to the liquidity of such instruments will affect economic growth, capital
investment and job creation”88
; interestingly, the estimated total collateral in
circulation related to non-cleared OTC derivatives has decreased 14%, from USD
3.7 trillion at the end of 2012 to USD 3.2 trillion at the end of 2013 as a consequence
of mandatory clearing89
.
It will be fascinating to assess whether this migration will be productive due to the
cost saving features of CCPs’ configuration90
, or the reduction of bespoke
products will negatively affect firms’ capability to efficiently finance and manage
risk in their operations and activities. Indeed, corporations may choose to reassess
their hedging strategy and decide not to hedge against those risks they used to in
the pre-reform scenario, as well as decide not to undertake a given commercial
activity, as the cost connected may outweigh potential revenues: this would have
disastrous effects on the global economic prosperity.
Conclusively, the RMT offer high standards of protection to counterparties involved
in non-centrally cleared transactions, however they do entail an important cost.
Initial margin will effectively defend non-defaulting counterparties in OTC
87 Investopedia
88 ISDA NON-CLEARED OTC DERIVATIVES: THEIR IMPORTANCE TO THE GLOBAL ECONOMY- MARCH 2013
89 ISDA Margin Survey - 2014
90 See Chapter II
51

transactions, nonetheless the net effect of such provisions will be assessable in the
next years, due to the unintended evils laying in the complexities of financial
interconnections: definitely, a new era for derivatives has become.
52

Concluding Remarks
We can conclude that the current framework is capable of reducing effectively
financial inefficiencies in the derivatives context, although some open questions
remain regarding the liquidity risk that may manifest quite soon as an unintended
effect of such structure.
In particular, in Chapter II we have seen that notwithstanding the consistent
benefits CCPs are expected to bring to financial markets in terms of trading
transparency and multilateral netting efficiencies, there is un avoidable drawback
regulators must now deal with: the concentration risks they inevitably pose to
derivatives market and to the whole financial system. Indeed, the decision to
make mandatory the central clearing of all standardised OTC derivatives implies
the constitution of new systematically important entities within financial markets.
Additionally, the higher costs correlated to non-centrally cleared OTC derivatives,
will plausibly cause market participants to rely increasingly on standardised
instruments. Once that trading will progressively migrate towards central clearing
however, credit, liquidity and operational risk will be concentrated in these
institutions. Consequentially, CCP could become new potential sources of systemic
risk under a new vest, eventually triggering the same kind of problems they were
trying to address.
In Chapter III, we argued that the forthcoming impact on the non-financial industry
of Initial Margin in non-centrally cleared derivatives transactions is expected to be
consistent, in terms of costs and risks to suffer losses due to markets illiquidity. In
ISDA view, “the importance to the global economy of the non-cleared OTC
derivatives market implies that any impairment to the liquidity of such instruments
will affect economic growth, capital investment and job creation”.
Conclusively, we can only end saying that wheter these risks will materialise or not,
it has to be witnessed: a new era for derivatives has become.
53

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55

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